Mortgage Rates Are Low, But It May Still Cost You

The news keeps talking about mortgage rates that continue to fall to almost unheard of low levels. We’re talking about 30-year fixed rate mortgages hovering just over 5%, and 15-year rates under 5% right now. These rates are sharply lower than just a few years ago. But just how much can you save with a lower mortgage rate? Surprisingly, the savings can be quite substantial, and finding the best mortgage can be tricky.

Let’s look at a $200,000 30-year fixed-rate mortgage. A few years ago your 7% mortgage would mean your monthly payment would be about $1,330 a month, less any PMI, escrow, etc. Now, take the same loan at 4% and the monthly payment drops to around $955. That’s nearly $375 less each month. I don’t know about you, but I wouldn’t mind having an extra $375 in my pocket each month. And when you look at the total savings over the life of the loan, the 4% rate will save you over $136,000 in interest. It’s no wonder people are looking to buy a house or trying to refinance right now, but is it worth it?

Tighter Lending Limiting Loans

Even though rates are low, it’s more difficult to get a loan or to refinance today. Banks have changed their lending standards and it takes very good credit to get the best rates. A few years ago almost anyone could get a decent rate. If you bought a home with good, but not great credit a few years ago, you may actually find that the rate you can get today is not much better than your current rate. In some cases, you may be unable to get a loan or refinance at all, especially with dropping home valus.

There are also new fees being introduced to help lenders deal with risk. New risk-based pricing from Freddie Mac and Fannie Mae adds fees to mortgages based on a borrower’s credit score. In order to avoid the extra fees, borrowers need to have a FICO score of 740 or higher. While a score in the 700s is historically pretty good, you can now find yourself on the hook for added fees even with a less than perfect score.

Thinking About Points

A lot of people think about paying mortgage points as a bad thing, but that isn’t always the case. The trend has been for lenders to require higher points for rates these days than a few years ago as they are looking for more money up front. Since points are essentially prepaid interest, this puts more money in the bank’s pocket early on. In some cases, paying points can result in a better deal, while some situations may end up costing the borrower more money. Generally, the longer you plan on staying in the home, the more attractive it would be to pay points.

Julian Hebron, vice president and mortgage consultant at RPM Mortgage in San Francisco says that paying points gets borrowers a bigger discount these days:

Historically, one point in fee gets borrower a rate that’s about 0.25% to 0.375% lower. Now one point gets the rate about 0.625% to 0.875% lower.

Recently, you could get a $417,000, 30-year fixed-rate mortgage at a rate of 5.625%, paying zero points. By paying one point (or $4,170) on the same loan, the rate went down to 4.875%, saving the borrower $261 per month in interest cost.

At this monthly savings rate, it takes 16 months to pay back the $4,170 and everything from that point forward is a benefit. Traditional breakeven periods are double this.

Other Fees and Costs

Aside from paying points and possibly paying a higher rate because of your credit score, you still have all the other costs to contend with. It costs money to prepare a loan, and the underwriting and origination costs can easily be a few hundred dollars. You’ll also need an appraisal, which can again cost a few hundred dollars.

When you factor in all the costs associated with closing on a new mortgage or even a refinance, you can often expect to pay at least 3% of the loan amount in fees. This is especially important when you’re thinking about a refinance as the costs may outweigh the benefit of a lower rate in some cases. When you consider a $200,000 laon may end up costing $5,000 or $6,000 in total to refinance, what’s the breakeven point? If you’re saving $200/month by refinancing, it may take you nearly three years to make it worthwhile financially. So, if you aren’t sure if you’ll be in the house for more than a few years it could end up costing you in the long run to refinance and pay the closing costs. Of course, closing costs and fees vary by lender and your specific home, so you’ll want to calculate what’s best for you.

A Lot of Things to Consider

As you can see, just because we keep hearing about how low the mortgage ratesare these days, it isn’t always as easy as going to your bank and getting a 4% or better loan. With banks limiting these rates to those with the highest credit, regular people with average credit may not be able to find a loan or refinance for anything near what’s being discussed in the news.

In addition, if your future is uncertain and you may need to move in the next few years, the added points required to get the low rate or the fees associated with a refinance may actually cost you more money if you ended up not staying in the house as long as you expected.

So, if you’re considering the purchase of a new home or refinancing your existing mortgage, it’s certainly worth checking around to see what kind of rates you qualify for. But you want to make sure you’re actually going to save money and you’re not just jumping into a decision because the rates are at historical low levels. There are deals to be had out there, but it may be harder to qualify for them, and there may be other strings attached that make the lower rate not as attractive as it seems.

My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.

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